The Affordability Trap
Firms targeting the BOP often fail because the products are much too expensive and not affordable by the poor. There are two lessons here. First, firms should not overestimate the purchasing power of the poor. Second, firms should adjust the cost-quality trade-off much more significantly to conform to the lower purchasing power of the poor.
Overestimating Purchasing Power
A surprisingly common mistake is that firms and researchers convert the income of the poor using purchasing power parity (PPP) exchange rates, but convert product prices using financial exchange rates. This mistakenly makes products seem more affordable by the poor. Since financial exchange rates are about two to five times higher than PPP exchange rates for most developing countries, this has a big impact on the apparent affordability of products.
The World Bank’s commonly used $2 PPP per day standard translates to about Rs. 30 per day in India, using the approximate PPP rate of Rs. 15 per dollar in 2005. Pricing a sachet of PUR at $0.10 makes it seem that the sachet costs 5 percent ($0.10 divided by $2.00) of the poor person’s daily income. But since the price was converted at the financial exchange rate of Rs. 45 per dollar, the sachet actually costs Rs. 4.5, which is 15 percent of the poor person’s daily income. This is one reason the repeat purchase rates for PUR were very low.
Another cause of overestimating the purchasing power is that firms do not fully appreciate the consumption patterns of the poor. Because basic necessities account for a large fraction of their meager income, there is not much room left for other expenditures.
Essilor justifies setting the price of eyeglasses at Rs. 200 on the grounds that they are priced at around one week of base salary in developed countries. This Rs. 200 per week is roughly consistent with the poverty line of Rs. 30 per day mentioned above. A European can afford to spend 200 euros, about 2 percent of his annual income on eyeglasses. Essilor uses appropriate exchange rates and takes into account the low income of the poor by considering prices as a fraction of income; it thus avoids the PPP exchange rate mistake discussed above, although even then it ends up overestimating the market potential. A poor person in India cannot afford to spend the same percentage of his annual income on eyeglasses since a much larger fraction of his income is needed for more “necessary” needs. The poor in India spend about 80 percent of their income on food, clothing, and fuel, making it difficult to buy a product even as useful as eyeglasses.17 This partly explains why the proportion of prescriptions that convert into actual purchases in Essilor’s initiative is below 40 percent.